As its fulcrum, banks tell us a lot about how chipper the financial system feels. And Europe's wholesale banks are feeling pretty optimistic.
Corporate loan books, for instance, grew by 9 per cent in the first half of 2005, as bullish companies geared up to fund acquisitions. Investors share their optimism. In July, UK net sales of retail products like unit trusts were running at 10 times the figure of a year before.
Credit Suisse points out that average lending margins, at less than 30 basis points above benchmark rates, are at odds with wider spreads in the credit derivatives market as well as historical risk/reward relationships. A big driver of this is private equity, with Europe's largest leveraged buyout fund yet, at €6bn, having closed in July. Banks are lending to sponsors at reduced margins to bolster relationships. Meanwhile, leverage multiples on European LBO's have reached their highest levels since 2000.
Optimists can point to historically low levels of leveraged loan defaults and slowing growth in European banks' trading books. But default rates can balloon in a slowdown. And while growth in value-at-risk for Europe's big banks has waned, VAR calculations probably understate the true risk as they rely heavily on recent equity market trends. These, of course, have been unusually benign, partly because of optimism on merger activity, buoyed to a large degree by LBOs, both actual and rumoured. In that sense, optimism is not just catching, it is circular.